Value Investing
An Analysis of value investing in the stock market
An Analysis of value investing in the stock market
Value investing is a time-tested long-term method of investing. Value investing is a very different approach to investing compared to what is popularized among the crowd. Most people who invest in the stock markets want a high return on their investment as quickly as possible, hence they use methods such as trading, stock tips, etc. But the stock market is a very complex place where infinite things are influencing the market in the short term and hence to predict what will happen tomorrow is near to impossible. Nobody knows the future so we should know our limitations and not try to speculate a lot, especially to get rich quick. Value investing sees the investing process in the stock markets as a place to buy a very good business for a long period at a fair value that is given by the market. This is a more logical and sustainable method of investing for a multitude of reasons. In the markets, one thing you need is delayed gratification which means that you must be prepared to forego a small return in the short term to get a better return in the long term. Value investing is a method which preaches delayed gratification. While Value investing is an investing method it is also considered an art because of the things that you have to go through psychologically to be successful in the stock market.
What is Value Investing?
In plain simple words Value investing is when you buy a business which is priced below its intrinsic value to provide you with a margin of safety. “ ‘Price is what you pay, Value is what you get.’- Benjamin Graham.”(Parikh 42) Value investing aims to be fearful during good times as the prices for companies good or bad are high and overvalued in comparison to their intrinsic value. When the markets are doing well the margin of safety goes away and hence investing in businesses becomes a little harder. During the good times when everyone is doing well, everyone gets a perception that they know what they are doing and they think they are experts. A good indicator for the market to be overvalued is when people who have absolutely no knowledge about business start giving you free advice on random stocks. On the contrary when markets are down and there is pessimism where the majority of the good businesses that in the long-term will be unaffected present themselves at very good valuations as their price is brought down but their intrinsic value has not gone down. This happened recently during covid and it is bound to happen multiple times over the long term because markets are reactionary and there are inefficiencies in the economy. The American market currently is down due to a recession and inflation. However, this makes it sound like value investing is just investing in companies which are cheap during bad times and selling them during good times. This is a misconception the main aim of a good value investor is to invest his/her money into a great business at a fair value. Think of it as if you are investing in the underlying business and once you buy the business think of yourself as a business owner. This helps make you focus more on the underlying business than the stock. To quote Charlie Munger “A great business at a fair price is better than a fair business at a great price.” (Munger). To summarise Value Investing is when you buy great businesses at a price below their intrinsic value and not get affected by the booms and busts.
How to Implement Value Investing?
To implement Value investing you need to know how to value a business. This part is a little complex. Everyone values businesses differently and there is nothing wrong with that. But there are a few important things that you have to look at to value a business. Firstly intrinsic value is what the company is worth solely based on its business and not related to the stock market’s valuation at all. There are two things you have to do: the quantitative side of deriving value and the qualitative side. To value a business you have to do the hard work of estimating future cash flows and earnings and then discounting them at an appropriate rate. This requires a good understanding of the business and the current environment. (Parikh 42) The problem with valuation is that you have to predict future cash inflows and outflows and earnings. The methods to predict the growth of earnings are based on many factors such as the company's competitive advantage and return on investments they make known as ROCE and ROIC, etc. So to value a business you have to see three things assets, growth and earnings. Now, this sounds very complex and it is. It is near impossible to derive an exact value for a company and if you do come up with an exact number you are most likely to be wrong. So all you have to do is figure out a range of value and not the exact value. This makes it a little easier and anyone can do this to figure out if a company’s price is above its value or below its value. When you see a company like Adani Green which has a net profit of Rs38cr in the last twelve months with a ROCE of 3.18% shows that they don’t have good returns on their investment meaning that growth prospects are low for the business. It wouldn’t take a genius to see that their market valuation of Rs3,30,136 Cr is flawed as it is very far from the real value of the business.
There is also one method of value investing which is a readymade solution and it is called magic formula investing it was formed by Joel Greenblatt in his book “The little book that beats the market”. The book provides us with a readymade formula consisting of two ratios ROCE and Earnings yield. One of them indicates growth and the other indicates that a stock is cheap. This preaches cheapness investing but if you want to do no research it is a good way to implement the basic idea of value investing. Joel Greenblatt has made a site for us stocks where the magic formula is used to pick stocks. It is www.magicformulainvesting.com.
Why Value Investing?
For anyone to use value investing you have to be convinced that it is the best method to invest and it gets you the highest returns and compounds your money in a better way than other methods. Value investing has been practised by some of the best investors in the world. Warren Buffet, Charlie Munger, Benjamin Graham, Peter Lynch, John Templeton, etc. all are value investors. They are value investors because they prefer the simple logic behind it and do not think that the complexity of the other methods is necessary to be successful. This is also what Charlie Munger’s famous mental model Occam’s Razor states. It states that the simplest alternative is the correct alternative more often than not. Warren Buffet who preaches Value investing is one of the world’s richest men who compounded his money since he was 12 using value investing. In India value investing started being used a little late but one of the founding fathers was Chandrakant Sampat. Then you have Parag Parikh, Chetan Parikh, Vishal Khandelwal, Radhika Gupta, Porinju Veliyath, Radhakishan Damani, Rakesh Jhunjunwala etc. They have all performed well in the long term and have outperformed the market.
The Parag Parikh Flexi cap fund founded by Parag Parikh generated 17.26% returns annually since its inception in 2013. If you put a SIP in this fund of Rs 10000 per month since its inception and sold it today your money would be worth a staggering Rs 26,27,131.50. (Moneycontrol. com) If you were busy trading money and were happy with small profits in the short term you would not have compounded your money at this rate. Let’s say for 9 years every day you continued to make profits in trading with a timeframe of a few days and you got the same return. You would still not make the same amount of money because short-term capital gains tax kills your return so the longer you hold on to your investment the more money you make. Now let’s analyse a few value investors.
Chandrakant Sampat:
Chandrakant Sampat was considered one of the first value investors in India. He led a very simple life and travelled by bus and spent most of his time at Hindu Gymkhana. He used to work out and run every day he gave value to fitness. Coming back to value investing he had a philosophy of investing in simple businesses which had low debt, good cash flow, paid dividends and did not have much capital expenditure. He also looked for companies which innovated. “Pick up good companies with good managements when their share prices are at an eight year or 10-year low. Alternatively, if you still want to do something, buy good companies that are 40 per cent lower than their 52-week high. I will buy only those companies that are in a business that even fools can understand, have very little debt, have free cash flows or do not have much capital expenditure, which is nothing but deferred cost.”(Chokshi) He had a very good performance but was an individual investor, not a fund manager. He was most influenced by Peter Drucker the famous economist. However, he has influenced a whole bunch of value investors and mentored them to reach the place that they have. He was the mentor for Parag Parikh, Radhakishan Damani, etc. He is an inspiration to the new generation with his learnings as well which is why he is considered the founding father of Value investing in India.
Radhika Gupta:
Radhika Gupta is the MD and CEO of Edelweiss Mutual fund. She got her education from the University of Pennsylvania- The Wharton School and she worked in USA hedge funds for some time before coming to India. She left her high-paying job to come to India and practice investing on her own and start her financial business journey. About value investing she has a Philosophy of keeping things simple. “In a podcast, she said, ‘Simplicity works and we don't price complexity well and we don't understand both the human risks and the costs of complexity.”(Khandelwal) She likes to follow the basic idea of buying companies which are great businesses and are priced fairly. She believes that complex systems have mistakes that we truly don’t understand and hence we should stay away from them. Her mutual fund has managed to get a staggering 19.19% average returns annually for the last 10 years. It beat the market comfortably and if you put a SIP of Rs 10,000 into the mutual fund on October 2012 right now you would have Rs 32,97,739.60. (Moneycontrol.com) Radhika Gupta is a top-notch investor but at the same time, she is an inspiration to everyone as she is one of the best investors in India in a male-dominated industry.
When we look at fund managers we can see that the people who follow the path of value investing are outperforming the others. Value investing is a simple concept which requires more of your psychological abilities than your knowledge or intelligence. This is why it is an art. The hardest part of Value investing comes after buying the business. You have to avoid being influenced by others and stick true to your conviction if you cannot do that you cannot be a Value investor. You do not need a high IQ you need a great temperament.
Conclusion
Value investing is a method to be chosen by a person who has a great level of temperament and a long-term mindset. A value investor has to be against the majority for most of his investing period and his returns will also not be great for some time but in the end, the Value investor is going to end up with a great return. The process of value investing is really simple and the ideology of keeping things simple instead of complex is one that usually works.
Works Cited
1. Parikh, Parag. “Value Investing.” Value Investing and Behavioral Finance: Insights into Indian Stock Market Realities, Tata McGraw Hill Education Private Limited, New Delhi, Delhi, 2009, p. 42.
2. Munger, Charlie. “Charlie Munger Quotes.” BrainyQuote, Xplore, https://www.brainyquote.com/quotes/charlie_munger_879429.
3. Moneycontrol.com. “Parag Parikh Flexi Cap Fund - Growth [47.2154]: - Moneycontrol.” English, Moneycontrol.com, 2022, https://www.moneycontrol.com/mutual-funds/parag-parikh-flexi-cap-fund-regular-plan/sip-calculator-MPP001.html.
4. Chokshi, Abhijit. “Thoughts on Markets and Life: Chandrakant Sampat.” Stockifi, 21 Sept. 2019, https://www.stockifi.in/blog/18/thoughts-on-markets-and-life-chandrakant-sampat.
5. Khandelwal, Vishal, director. Radhika Gupta on Living a Brave Life and Creating Your Own Destiny. YouTube, YouTube, 13 July 2021,
Accessed 15 Oct. 2022.
6. Moneycontrol.com. “Edelweiss Mid Cap Fund - Regular Plan - Growth [52.103]: Edelweiss Mutual Fund - Moneycontrol.” English, https://www.moneycontrol.com/mutual-funds/edelweiss-mid-cap-fund/sip-calculator-MJP007.html.